Avoiding tax is probably the best-known investment advice, and the mission that unites even the least sophisticated investors with the most financially literate.
How the government wants you to avoid paying tax
As a wise blogger (SHMD, I think it was, but I can’t find the link) pointed out recently, the UK offers unusually generous investing tax breaks (and that’s even before we get onto SEIS and EIS angel investing tax breaks). There’s almost no point in calling Panama.
For most UK investors, the simplest way to avoid taxes involves two manoeuvres, each done annually:
- Topping up your ISA(s). ISAs remain the biggest potential tax break in the UK, but they require multi-year patience; there is an annual ‘use it or lose it’ allowance so to maximise the benefits you need to act annually. The limit these days is £20k per adult, so £40k per couple – which is a lot of money to find from disposable income but not enough to squirrel a large inheritance/windfall/25% pension drawdown away all in one go.
- Making pension contributions. For most retail investors, pensions are a fairly straightforward tax break; in exchange for locking my money up until I’m c.60, I avoid any tax on the money from now until I start accessing it. For more affluent but nowhere-near-retirement-age investors, such as me, the UK policy is pretty crazy, because knowing whether your pot is going to breach the ceiling 20+ years out is a mad Monte Carlo guessing game. A 30 year old expecting to retire at 70 and expecting annual returns of 7% should be careful about taking their pot above £60k.
It is worth stating the obvious that not only are these two manoeuvres both 100% legal but they are in fact actively encouraged by government policy.
Practically all the readers of this blog are at least higher rate tax payers – i.e. their marginal income tax rate is 40% or more. For them the two key rates on offer are 40% and 0%.